Risk Rating System for DOVs

Introduction

Risk Rating Methodology

  1. Volatility is a mean reverting process
  2. We should not long or short volatility based on absolute values alone. We need to consider the volatility of volatility, to contextualize the current volatility regime
  3. Volatility tends to cluster, be it low volatility or high volatility regimes

Procedure

  1. Compute the absolute Zscore of SMA30 of annualized realized volatility (Zscore gives us the “Vol of vol”)
  2. We define a high risk condition when the Zscore is either < 0.5 or > 2
  3. To determine if a call or put carries more risk, we consider the current market trend through SMA100

Results

An example of BTC

Summary

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